As expected, the Court this morning reversed the Eleventh Circuit’s decision in Clarke based on the Court’s agreement with the government’s position that the Eleventh Circuit erroneously had required an evidentiary summons enforcement hearing based on nothing more than the bare allegation of an improper purpose. See our previous report here. But the Court’s unanimous opinion, authored by Justice Kagan, went on to attempt to provide guidance for future disputes over the availability of such hearings, including the resolution of this case on remand, and that guidance could perhaps lead courts to allow such hearings more often than in the past.

The Court summarized the standard to be applied by a court in considering the summoned party’s request for a hearing as follows: “whether the [summoned party has] pointed to specific facts or circumstances plausibly raising an inference of improper motive.” It elaborated on that standard to some extent elsewhere in the opinion, although the general language still leaves considerable room for interpretation by the lower courts:

“[T]he taxpayer is entitled to examine an IRS agent when he can point to specific facts and circumstances plausibly raising an inference of bad faith. Naked allegations of improper purpose are not enough: The taxpayer must offer some credible evidence supporting his charge. But circumstantial evidence can suffice to meet that burden; after all, direct evidence of another person’s bad faith, at this threshold stage, will rarely if ever be available. And although bare assertion or conjecture is not enough, neither is a fleshed out case demanded: The taxpayer need only make a showing of facts that give rise to a plausible inference of improper motive. That standard will ensure inquiry where the facts and circumstances make inquiry appropriate, without turning every summons dispute into a fishing expedition for official wrongdoing.”

The immediate result of the decision is a remand to the Eleventh Circuit to determine whether the district court’s refusal to order an evidentiary hearing comported with this standard. The Court did not express a view on whether the evidence that the private parties had put forth (alleging retaliation for failure to agree to a statute of limitations extension and an ulterior motive to conduct the equivalent of discovery for the Tax Court case) met the standard, stating that whether those purposes would be improper was not within the question presented to the Court. But the Court did set forth some principles for how the Eleventh Circuit should go about reviewing the district court’s decision.

At the outset, the district court’s decision is entitled to deference and is reviewed for abuse of discretion. But the Court emphasized “two caveats” to that discretion. First, no deference is owed if the district court did not apply the correct standard. Second, no deference is owed to the district court’s decision on “legal issues about what counts as an illicit motive.”

In that connection, the Court proceeded to state that this second caveat encompassed the issue to which the private parties have attached considerable importance – namely, the contention that the IRS was seeking to enforce the summons only in order to obtain discovery for the Tax Court proceedings. The district court had agreed with the government that this would not constitute an improper purpose because the validity of a summons should be judged as of the time of issuance (which was before the Tax Court proceedings were initiated), not as of the time the IRS moves to enforce the summonses. The Supreme Court declined to endorse that argument, inviting the Eleventh Circuit to consider it as a legal issue on which it owes no deference to the Tax Court.

Thus, the government has dodged a bullet in Clarke, with the Supreme Court reversing the Eleventh Circuit and rejecting the proposition that IRS agents can be hauled into an evidentiary hearing on the basis of a bare allegation of improper purpose. But the government could well find itself facing a loss again on remand when the Eleventh Circuit applies the standard set forth in Clarke to the evidence in this case. There is nothing in the Supreme Court’s opinion to discourage the Eleventh Circuit (presumably the same judges who already voted once to afford an evidentiary hearing in this case) from concluding that the private parties here did make a sufficient showing because, as a matter of law, it is improper for the IRS to move to enforce a summons for the purpose of obtaining information to be used in pending Tax Court proceedings. It will be worth following the remand proceedings in the court of appeals to see how the Eleventh Circuit deals with this issue.

It is now six weeks since the Supreme Court heard argument in Clarke regarding the circumstances under which a court must convene an evidentiary hearing in a summons enforcement proceeding to allow IRS officials to be questioned regarded their reasons for issuing the summons. Based on the way the case was litigated and the questions at oral argument, the government is likely rooting for a relatively narrower opinion, whereas taxpayers who might someday be disputing a summons hope that the Court will take this opportunity to elaborate and provide new guidance on summons enforcement proceedings.

The dichotomy between a broad approach and a narrow approach has been reflected all through this case, beginning with the divergent ways in which the two parties framed the summons dispute in their questions presented. See our prior coverage here. The government has sought to focus narrowly on the precise holding of the court of appeals, while the private parties have asked the Court to look more broadly at all the circumstances of the case and to take a fresh look at how summons enforcement proceedings are generally conducted.

Specifically, the government contended from the start that the Eleventh Circuit had laid down an indefensible blanket rule that a party is entitled to an evidentiary hearing to challenge a summons so long as it alleges an improper purpose. That rule, according to the government, would dramatically increase the extent to which IRS agents are hauled into court for evidentiary hearings and is inconsistent with longstanding summons enforcement law. The parties challenging the summons enforcement proceeding, conversely, have argued that the Eleventh Circuit decision was narrower, pointing to the facts in this case that supported their allegations, albeit facts that for the most part were not relied upon by the court of appeals. Notably, the government has acknowledged that a district court has considerable discretion in deciding when an evidentiary hearing should be held and conceded that a district court appropriately could have scheduled a hearing here. The government objects only to the court of appeals ordering the district court to hold an evidentiary hearing when the district court had already exercised its discretion to deny the private parties’ hearing request.

The Justices inquired into both approaches to the case during the oral argument. It appeared that the Court was in harmony with the government’s narrow view of the Eleventh Circuit’s holding and thus of the bare minimum that has to be decided in the case. In fact, when government counsel began the argument by attacking the court of appeals’ specific statements, Justice Scalia quickly interjected to say that the other side “concedes all that” and that “nobody defends what the lower court said here.”

But the questioning also suggested that the Court might not be content to write an opinion that does the bare minimum – that is, one that just reverses the court of appeals for requiring an evidentiary hearing based on no more than a bare allegation of an improper purpose. Rather, the Court expressed plenty of interest in other aspects of the summons enforcement procedure and raised the possibility that it would use this decision as a way of giving more guidance to trial courts on when hearings would be appropriate in handling these proceedings. Indeed, Justice Alito criticized one of government counsel’s suggestions as not being “very helpful to a district judge” and the Chief Justice noted a desire to give “clearer guidance.” Thus, there appears to be a good possibility of a decision reversing the Eleventh Circuit, and thus ruling for the government, but containing language to guide district courts in the future that the government could find problematic.

In particular, the Justices showed interest in the point on which the private parties laid the most stress in arguing that they had evidence of an improper purpose – namely, the circumstances strongly indicating that the IRS was seeking to enforce the summonses as a way of developing evidence for the Tax Court proceeding rather than for the audit. The government had argued that this issue was not before the Court since the Eleventh Circuit did not rely on it, and also contended that there was no caselaw holding that this was an improper purpose. It also argued that the improper purpose determination relates to the issuance of the summonses and therefore is not to be based on the situation at the time of the enforcement proceedings. It is not apparent, however, that these arguments will carry the day. At least four Justices (Kennedy, Alito, Breyer, Ginsburg) showed interest in this point and evinced some degree of concern whether it would be proper for the IRS to enforce the summonses to aid its position in the Tax Court proceedings. Justice Breyer did question whether, given the posture of the case, the Court could decide the legal question whether aiding the Tax Court proceedings would be an improper purpose. Thus, there is a good chance that the Court’s opinion will leave this issue to be resolved on remand.

At the end of the argument, Justice Kagan asked government counsel to elaborate on what kind of evidence the government would agree would overcome the presumption that a summons was issued for a proper purpose. Counsel pointed to the two improper purposes identified in Powell – harassment and an attempt to pressure the taxpayer into settlement in a collateral matter – asserting that the taxpayer ought to have some evidence in its possession if the latter purpose existed. The Court may be tempted in Clarke to crack open the door a bit more for allegations of improper purpose, but it is unlikely to throw the door open as wide as the Eleventh Circuit appears to have done.

In any event, the answer will come soon. The Court could issue its decision as early as Thursday, and will almost certainly act by the end of June.

All of the briefs have now been filed in the Barnes case. The government’s response brief defends the Tax Court’s decision as a run-of-the-mill application of substance over form principles. Quoting from True v. Commissioner, 190 F.3d 1165 (10th Cir. 1999), it argues that the step-transaction doctrine applies because the “Bermuda/Delaware exchanges did not ‘make[ ] any objective sense standing alone’ without contemplation of the other steps.” In arguing that these steps served no business purpose, the government relies heavily on evidence that the “reinvestment plan” was based on tax planning that the taxpayer’s accountants had previously done for another client. The government asserts that “Barnes and PwC went to great lengths to create out of whole cloth a business purpose for a tax-avoidance plan that originated in PwC’s database.” Rather than a legitimate business plan, the government alleges that “the entire repatriation scheme consists of essentially nothing more than a circular flow of funds among Barnes and its wholly owned subsidiaries.”

The government’s brief also notes that, if the court of appeals is unpersauded by the Tax Court’s opinion, it should remand for additional factual determinations to resolve two alternative government arguments that were not reached by the Tax Court: 1) that the transaction had the principal purpose of tax evasion and therefore deductions could be disallowed under Code section 269; and (2) that the Delaware preferred stock was held under the anti-abuse rule of Treas. Reg. § 1.956-1T(b)(4).

With respect to the issue discussed in our previous post regarding the taxpayer’s argument that the government was prohibited from disavowing Rev. Rul. 74-503, the brief largely tracks the Tax Court’s discussion. In other words, the government does not question the soundness of the principle stated in Rauenhorst that the IRS cannot argue against its Revenue Rulings. Rather, the brief simply doubles down on the step-transaction point and argues that the taxpayer could not reasonably rely on that ruling here because this case does not involve “bona fide § 351 exchanges.”

With respect to the penalty issue, the government again criticizes PwC’s role, arguing that PwC had a “conflict of interest” in issuing an opinion regarding the transaction because it had an interest in a favorable tax result that would allow PwC to “market [the tax plan] to other corporations seeking to repatriate funds from a controlled foreign corporation.” Accordingly, the government argues that the taxpayer could not reasonably rely on the PwC letter for “objective advice.” The government also argues that the taxpayer could not reasonably rely on the opinion because “PwC did not opine on the integrated repatriation scheme as a whole.”

The taxpayer’s reply brief argues that the government’s brief “mischaracterizes the substance of the plan” because the Bermuda and Delaware subsidiaries did not operate as conduits for a dividend payment. Instead, it accuses the government of making a policy-based argument that would “impermissibly convert Section 956 into an anti-abuse rule.” The brief then disputes in detail the government’s description of the transaction and underlying facts.

With respect to the penalty issue, the reply brief states that the government “essentially rewrites the Tax Court’s factual findings” in criticizing reliance on the PwC opinion. The brief notes that PwC was Barnes’ long-time tax advisor and did not market the transaction to Barnes. It also states that the Tax Court held that the PwC advisor “was a competent professional who had sufficient expertise to justify reliance” and that Barnes “provided necessary and accurate information to the advisor.” In particular, the reply brief responds to the government’s “conflict of interest” accusation against PwC by noting that the Tax Court specifically observed that there was nothing “nefarious” about PwC keeping tax planning ideas in a database and by asserting that “the government’s unfounded assertions that PwC did not provide an adverse opinion in order to sell the transaction to others is ludicrous and without any factual basis.” The reply brief also argues that the government is incorrect in stating that the PwC opinion did not address the entire transaction, quoting the PwC opinion itself as stating that it “is premised on all steps of the proposed transaction.”

The government has now filed its reply brief in MassMutual. The brief begins by asserting that the taxpayer has abandoned on appeal an argument that had persuaded the trial court — namely, “reliance on its annual-dividend obligation to individual policyholders to establish the fact of its liability under the dividend guarantees.” In the government’s view, that “about-face is fatal to its case.” The reply brief then addresses the taxpayer’s reliance on the Washington Post case. See our previous report here. It argues that, “unlike the group obligations in Washington Post, the alleged group obligations in this case were not otherwise fixed as to liability in the years in which the dividend guarantees were adopted” for reasons unconnected to the indeterminate membership of the group. The rest of the brief hews more closely to the topics discussed in the government’s opening brief, including the Supreme Court’s decision in HughesProperties and the Second Circuit’s decision in New York Life. See our previous report here. The reply brief also argues again that its economic performance regulation is entitled to Auer deference.

About Miller & Chevalier’s Tax Appellate Blog

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The Tax Appellate Blog is intended to be a resource for information on important tax cases under consideration in the appellate courts. It will feature insightful commentary on the issues and provide a dedicated site for following the progress of these cases.

Authors

Steve Dixon is a Member in the Tax Department at Miller & Chevalier. He specializes in controversy and litigation, representing taxpayers in the Tax Court and Federal courts.

Laura Ferguson is a Member of the Supreme Court and Appellate Litigation Group at Miller & Chevalier and has successfully briefed and argued six cases at the U.S. Courts of Appeals in the past two years. Ms. Ferguson also has extensive experience litigating complex, high-stakes tax cases at the Tax Court and federal district courts.

Alan Horowitz is the former Tax Assistant to the Solicitor General at the Department of Justice, where he briefed and argued numerous tax cases in the Supreme Court. He is currently the head of the Supreme Court and Appellate Litigation Group at Miller & Chevalier.